CBT loopholes are not new. In 2013, the Yankees used some creative accounting to turn Vernon Wells’ bloated contract into a luxury tax rebate for the following year. The Yankees’ never did get below the threshold in 2014, but a similar strategy might have made trading Jacoby Ellsbury more palatable this off season…if only the loophole hadn’t been closed. Because the new CBA stipulates that cash consideration be applied on a “pro-rata basis over the remaining Guaranteed Years of the assigned Contract”, teams no long have the ability to use selectively applied cash payments to avoid the tax man.

MLB has done a good job making its CBT system iron clad, but there is at least one wrinkle that teams can still exploit. Guaranteed years are defined by the CBA as “any championship season included in a Uniform Player’s Contract for which more than 50% of the Player’s Base Salary is guaranteed by the Contract in the event of termination.” So, what’s the loophole? 50%.

Because only 50% of a player’s base salary must be assured to qualify as a guaranteed year, player options can be structured in such a way to make a one-year contract appear much smaller in terms of its average annual value (AAV). The chart below illustrates how the loophole would work, but prefacing the data with a real world example provides for a clearer explanation. Let’s say the Yankees would like to sign Jake Arrieta and still remain below the luxury tax threshold. With only about $25 million of wiggle room, even a one-year pillow contract could push the Yankees to the limit. However, if a player option was added, the Yankees could guarantee Arrieta more money on a one-year deal, while considerably lowering the AAV impact.

The “Guaranteed Year” Loophole

Luxury Tax = Base/Guaranteed Years* 2018 Guarantee = AAV + Opt out payment Injury Insurance = Base – 2018 guarantee *Player option years are guaranteed if the buyout is not more than 50% of the base. Years after an opt out are guaranteed if buyout is not more than 50% of remaining amount owed on all years.

Source: MLB CBA, proprietary calculations

Here’s how the loop hole works. For luxury tax purposes, the base value of a contract is divided by the guaranteed years. As noted above, player option years are guaranteed if the buyout is less than 50% of the base, or in the case of a multi-year deal, less than 50% of the remaining amount owed on all subsequent years. Because AAV is determined by using guaranteed years in the denominator, the more the better. So, getting back to our example, the Yankees could offer Arrieta a two-year deal worth $36 million in base salary, but with a $9 million buyout. Because the buyout is not more than 50% of the annual base, the second year would be considered guaranteed, making the AAV (i.e. luxury tax hit) only $18 million. Presumably, Arrieta would sign the deal with the intention of declining the player option and taking the buyout, making his one-year salary $27 million.

The benefit to the Yankees from this arrangement is obvious. They would get Arrieta for one year and still have a chance to stay below the luxury tax threshold in 2018. Granted, in 2019, their AAV payroll would end up having to account for the $9 million buyout, but at that point, the tax rate would have been rest from 50% to 20%. Of course, if Arrieta decided not to opt out (because of injury or poor performance), the Yankees would be on the hook for his entire 2019 salary, but that is the typical risk taken with any long-term deal.

For Arrieta, the advantage is a little more nuanced. Not only would the $27 million guarantee likely be higher than the average annual value of a potential long-term deal, but it would also come with a quasi-insurance policy of $9 million. So, if an injury or poor performance were to occur, Arrieta would have more guaranteed money upon which to fall back. That clearly wouldn’t mitigate the lost earnings associated with a long-term deal, but it is an offset. And, if the risk of lost salary from eschewing a bigger deal is a concern, one of the longer-term structures illustrated above could be considered. These would progressively lower the Yankees’ AAV in 2018, while providing Arrieta with a larger “insurance policy”.

Who said paying taxes was guaranteed? With a little creativity, teams on the cusp of the luxury tax threshold can still be spenders, and free agents who have been adversely impacted by the current CBA can use the very same restrictions to maximize their earning potential. Now, if only there was a loophole to get around that other great certainty of life.